Alternate Investments

Private Equity: The Future of Investing for the High-Net-Worth Individual

India is witnessing a dramatic shift in the size and composition of foreign investment inflows. Institutional investors in developed countries increasingly seeking new destinations and innovative asset classes to diversify their portfolios. Private equity is one of the most attractive alternative asset classes in India. Further, It offers investors the potential to generate high returns by investing in companies with strong growth potential.

It is a type of investment that involves investing in private companies. Subsequently, Private equity firms raise money from investors and use it to invest in companies that they believe have the potential to grow and appreciate in value.

The private equity sector in India is broadly defined as investing in a company through a negotiated process. Also, Investments typically involve a transformational, value-added, active management strategy. Typical forms of private equity include venture capital, growth, buyouts and mezzanine.

The major PE investments influencing deal values in India are Fintech, Consumer tech, Saas and Energy sectors. Other sectors that have significantly contributed to private equity deal value include BFSI and Telecom. Although, The most active sectors in terms of deal volume are IT/IT Services and Manufacturing. Other sectors contributing significantly to deal volume include Banking, Finance and Insurance, and Real Estate.

What are the different types of private equity investments?

PrivateEquity_Lifecycle_PAWealth

There are several types of private equity in India, each with its unique characteristics and objectives. The primary private equity types in India are:

Venture Capital

Venture capital is a form of private equity investment that provides funding to businesses and early-stage companies that have high growth potential. Also, Its investors typically acquire an equity stake in the company in exchange for funding and provide strategic guidance and operational support to help the company expand.

Growth Capital

Growth capital is a form of private equity investment that provides funding to companies that are in their early or growth phases. Further, These funds are typically used to finance expansion plans, research, and development, or working capital requirements.

Growth comes into play further along in a company’s lifecycle: once it’s established but needs additional funding to grow. As with venture capital, growth equity investments gran in return for company equity, typically a minority share. Unlike venture capitalists, growth investors can research the company’s financial track record, interview clients, and Try the product themselves before deciding if the company is a wise investment choice. Any investment presents a risk, but in the case of growth equity, the company has the chance to prove it can provide a return before the private equity firm invests.

Buyout

A buyout is a form of private equity investment that entails the purchase of a controlling stake in an established company. Subsequently, Buyouts are typically made by PE firms that seek to restructure and enhance the operations of the company to increase its profitability.

Mezzanine Finance

Mezzanine finance is a form of PE investment that provides capital to companies that are in their expansion stage. However, This financing is typically structured as a hybrid between debt and equity. These funds are used to finance growth initiatives or acquisitions.

Why Should You Consider Investing in Private Equity?

Private equity investments offer two key benefits:

First, they provide access to unique investment opportunities not available in public markets, as more value is now generated in private ownership.

Second, PE managers collaborate closely with portfolio companies, driving growth and efficiency. Also, Their concentrated ownership allows them to exert significant influence, and their expertise in business expansion, strategy, operations, and technology integration is crucial in today's dynamic environment. Also, These factors make PE a source of differentiated, attractive returns that historically outperform public markets.

Private equity investments provide distinct advantages. First, They offer access to unique opportunities unavailable in public markets, with companies staying private longer. PE managers actively work with their portfolio companies, leveraging concentrated ownership to drive growth and efficiency. Historically, PE has consistently delivered superior returns compared to public markets(See below).

Private Equity_returns_PAWealth
Figure 1: A bar graph depicting returns of Private vs Public(MSCI Emerging Markets) equity over various time horizons.

Comparing PMEs of S&P500 with MSCI World Index using Kaplan Scholar PME (Private Market Equivalent)

PME is a popular solution to mitigate the timing issues associated with comparing public and PE performance. PME compares the returns generated by investing in PE funds with those achieved by investing the same funds in a public index during the same period.

One of the most common PME measures is the Kaplan-Schoar approach. It computes the ratio of the returns from PE investments to returns from the public market. Further, A PME greater than 1 indicates that PE has outperformed the public markets while a PME less than 1 indicates that public markets have outperformed PE.

Figure 2 shows the Kaplan-Schoar PME for PE funds from vintage years 2000-2018 benchmarked with the S&P 500 and MSCI World Index. Subsequently, The PE funds have consistently outperformed public markets over the same period for most of the years between 2000 and 2018(See Below).

Private Equity_returns_PAWealth
Figure 2: A table showing PME for multiple years of the S&P500 and MSCI World Index. A PME greater than 1 indicates that private equity has outperformed the public markets, while a PME less than 1 indicates that public markets have outperformed private equity.

What are the different types of exit strategies available to private equity investors?

Initial Public Offering (IPO):

Taking a portfolio company public through an IPO is a popular exit strategy. Furthermore It involves selling shares of the company on a stock exchange, allowing the PE firm to cash out some or all of its holdings.

Benefits: Provides liquidity, typically achieves the highest valuation, and can generate significant returns.

Considerations: Market conditions and also regulatory requirements can impact the timing and success of an IPO.

Strategic Sale (Trade Sale or M&A):

Selling the portfolio company to another strategic company or competitor is a common exit route. This can be in the form of an outright sale or merger.

Benefits: This can result in a quick exit, and access to a buyer's existing resources. Consequently, It often generates a premium for the company's strategic value.

Considerations: Finding the right buyer and negotiating favorable terms are essential.

Secondary Sale or Sale to Another PE Firm:

PE firms may sell their stake in a portfolio company to another PE firm. This secondary sale can provide an opportunity to realize profits.

Benefits: This can provide a quicker exit than an IPO, especially if the company is not yet ready for public markets.

Considerations: Finding a willing buyer and especially negotiating terms are critical.

Recapitalization:

In a recapitalization, the PE firm and the portfolio company's management team may decide to take on additional debt or equity to provide liquidity to the PE firm.

Benefits: The PE firm can recover some or all of its investment while retaining an ownership stake in the company.

Considerations: The company's financial health and debt capacity must support this strategy.

Liquidation or Wind-Down:

In situations where a portfolio company faces insurmountable challenges or is no longer viable, Henceforth, a PE firm may choose to liquidate the assets and distribute the proceeds to LPs.

Benefits: Provides a way to recover some capital in challenging situations.

Considerations: Typically results in lower returns compared to other exit strategies.

Finding the Right Partner

While aggregate performance is strong. However, The dispersion of returns across individual investments, and, indeed, across diverse managers in PE can be substantial. This makes locating the correct partner critical. While, Manager skill is not evenly distributed, as exemplified by the high degree of performance dispersion among PE funds, magnifying the significance of manager selection. Firms with extensive experience through market cycles and extended global reach are better positioned to effectively deploy investor capital in value-creating investments.

Drop us your query at – info@pawealth.in or Visit pawealth.in

References:  Cambridge Associates | Prequin Alternative Assets Data | The Evolution of Private Equity Industry - Community Paper, August 2022, World Economic Forum.

Disclaimer: The report only represents the personal opinions and views of the author. Also, No part of the report should be considered a recommendation for buying/selling any stock. Thus, the report & references mentioned are only for the information of the readers about the industry stated.

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